The vagaries of the weather can play havoc with a farmer’s profits.  A bumper harvest can be followed by a very lean one - all because of a sudden adverse movement in the barometer.

To provide some relief in this respect, a claim can therefore be made for the profits of a qualifying trade to be averaged over two consecutive years and thus achieve, for tax purposes, a smoothing out of these peaks and troughs. This tends to be referred to as “farmers’ averaging” because a qualifying trade is defined in s.221(2) ITTOIA 2005 as being one of UK farming or market gardening or the intensive rearing of livestock or fish for human consumption. The key provisions are contained in s.222(1) and permit an averaging claim to be made where the profits of one year are less than 75% of the profits of the consecutive one, or in one of the two years a loss is made (thereby making the profits nil).  The benefit of making the claim is of course to avoid higher rates of tax in the better of the two years, or where relevant to take greater advantage of lower banding levels (e.g. the lower profits limit for Class 4 national insurance contribution purposes).

s.223 details exactly how the averaging works – this is written in a very user-friendly way and therefore you should be able to use it easily in the exam room and not worry about committing the rules to memory;

• If the profits are less than 70% of the other year, or the profits of one of the years are nil, full averaging is possible
• If the profits are between 70% and 75% of the other year, partial averaging applies. An amount is deducted from the higher year’s profits and added to the lower year’s profits – this amount is given by the formula (s.223(4));
  
  (D x 3) – (P x 0.75)
  
  Where D = the difference between the relevant profits of the two years, and P = the relevant profits of the higher of the two years

Claims have to be made in chronological order – so a claim to average the profits of 2013/14 and 2014/15 must be made before one to average the results of 2014/15 with 2015/16.  Once an averaging claim has been made, the averaged figure of the later year replaces the original result and then that may be further averaged with the result of the subsequent year, if the conditions are satisfied. However, under s.222(4), averaging cannot be made in respect of the year of commencement or cessation of trade, nor can it be made in cases where the cash basis is being used (s.221A)

If there are any losses for a particular year, averaging claims do not affect the availability of the usual loss reliefs which are still available for offset against averaged profits

The following provides an illustrative example of how the provisions work.

Solution

Since averaging is a claim it is subject to a deadline and s.222(5) specifies this as on, or before, the first anniversary of the filing date of the second of the two years concerned – so a claim to average the profits of 2013/14 with 2014/15 would need to be made by 31.1.17.

If a claim is made, the self-assessment of the first year is not affected.  Instead, under paras. 3 and 4 Schedule 1B TMA 1970, an adjustment is made to the liability of the second year.  As a consequence, payments on account of the second year (which are based upon the results of the first) are not revised to take into account the change in the profits attributed to the first year. This works to the taxpayer’s advantage when profits are rising, but works against the taxpayer when the second year's profits are lower than those of the first.

The Herd Basis

Farmers normally keep herds as trading stock and this is the basic premise for tax purposes – however where the animals are being kept for what they produce rather than for direct resale (e.g. a dairy herd or a herd of bulls which is not kept for slaughter but for their offspring) then under s.111 ITTOIA 2005 an election can be made to treat the herd as capital in nature rather than as trading.

The main benefits inherent in such an election are that the costs of maintaining the herd are deductible against trading profits, and any profit on the eventual disposal of the herd or flock is dealt with under the capital gains rules rather than as trading income, thereby making it exempt by virtue of the wasting chattel exemption

The election, which is an irrevocable one, applies on a herd by herd basis (i.e. to a specific class of animals) and must be made within one year of the normal due filing date of the tax return relating to the period in which the herd was first acquired. By way of an example, if the herd was acquired in the year ended 31.12.15, the results of this period would form the basis of the assessment for the tax year 15/16 and the election would therefore need to be made by 31.1.18

Once made, the initial cost of the herd is not tax deductible and subsequent movements in its value have no tax impact. If an additional animal is bought for the herd its cost is not tax deductible but if an animal is replaced the net cost to the farmer of the replacement is allowable for trading purposes.  Not surprisingly there are fairly detailed rules as to what does, and does not, count as a replacement for these purposes. 

If a farmer introduces an animal into the herd which has previously been part of his trading stock, the costs incurred so far have to be brought into account as a trading receipt (thereby in effect cancelling out the deductions which have previously been obtained)

If, the odd animal, or just a few animals, are sold without replacement, the proceeds are dealt with as normal trading profits but if the whole, or substantially the whole, of the herd is disposed of without replacement the proceeds are not taxed.

Similar to averaging, the herd basis rules do not apply where the cash basis is being used to calculate the profits of the trade. 

Steven Swann

The author is a tutor at Kaplan Financial